Return on Invested Capital

By Mark E. Peiler, CFA – Senior Vice President, Chief Investment Officer, mpeiler@bnccorp.com

On March 6, 2009 the S&P 500 index reached an intraday low just under 667, nearly 58 percent below its 1,576 October 11, 2007 high. Five years after the 667 low, the S&P 500 closed at 1,877 on March 6, 2014. The table that follows summarizes the results from an equity screening process of the broader Russell 3000 index for each of these three dates.

 
Oct. 11, 2007
March 6, 2009
March 6, 2014
S&P 5001,5766671,877
Russell 3000 Stocks With ROIC > 15% and EV/EBIT < 10X11631157
Russell 3000 Stocks With ROIC > 15%484403318
Russell 3000 Stocks With EV/EBIT < 10X3111,274220
Source: Bloomberg

Observation #1: The share of the Russell 3000 stocks with a Return on Invested Capital (“ROIC”) greater than 15 percent is relatively stable between 10 and 20 percent of the stocks in the index. This scarcity is why a high ROIC is one of the foundations in BNC Wealth Management’s value investing process. Presently, stocks with a ROIC greater than 15 percent are rarer than in the two other dates presented.

Observation #2: In contrast, notice how changes in valuation can dramatically impact the availability of stocks with low multiples of Enterprise Value to Earnings Before Interest and Taxes (“EV/EBIT”). The number of stocks with an EV/EBIT multiple of less than 10X increased from 311 (approximately 10 percent) on October 11, 2007 to 1,274 (over 40 percent) on March 6, 2009. Five years after the S&P 500’s March 6, 2009 trough, only 220 (approximately 7 percent) possess an EV/EBIT multiple of less than 10X. Furthermore, only 57 stocks currently exhibit a ROIC greater than 15 percent AND an EV/EBIT multiple of less than 10X, down from 311 on March 6, 2009.

Takeaway: The opportunity set of solid businesses available at low valuations was highest at the market’s low point when fear and bearishness were also running high. In contrast, high bullish sentiment typically coincides with periods following recent market strength. Unfortunately, it is these environments when the ability to own solid businesses at low valuations is extremely limited.

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